US economic data points to strong growth that may taper off towards the end of the year

Tougher consumer spending and a decisive decline in the merchandise trade deficit show that the US economy is quickly emerging from the doldrums in the first quarter.

Maintaining that momentum later this year is more of a question mark, as manufacturing and housing weaken along with job and wage growth. Inflation, although somewhat moderate, remains high and the Federal Reserve will continue to apply more force on the brakes on monetary policy.

In April, inflation-adjusted household purchases posted the biggest advance in three months and will help hope for a GDP recovery this quarter. The goods trade deficit, a major contributor to the 1.5 percent annual drop in gross domestic product in the first quarter, narrowed last month to the largest number since 2009.

While these developments are cause for optimism about the economy, regional manufacturing surveys have shown headwinds, while capital goods orders have eased somewhat.

Next week, the government is expected to report that job growth slowed in May, indicating that demand for labor is beginning to decline. That may help ease wage pressures later this year and eventually give central bankers some reassurance as they try to rein in inflation.

Consumer flexibility

Consumer spending was solid in April, rising 0.7% based on the rate of inflation. But the savings rate has fallen to its lowest level since 2008, indicating that Americans are increasingly relying on savings as price pressures squeeze budgets.

The increase in spending was across the board, driven by goods and services. Economists had expected demand for services such as travel and entertainment to outpace expenditures for goods as pandemic fears eased, but inflation-adjusted spending on goods rose 1% in April from the previous month and services rose 0.5%.

“The report shows that consumers continue to consume despite facing the highest rate of inflation in 40 years,” Wells Fargo & Associates economists Tim Quinlan and Shannon Serry wrote in a note. “But we are nearing the end of the lollipop,” they said, noting the decline in the savings rate.

At the same time, while inflation is falling year-on-year, it is still advancing three times faster than the Fed’s 2% target and helps explain why central bank officials expect to implement half-point rate increases in upcoming meetings. Wells Fargo economists wrote that this could also lead to lower consumer spending in the coming quarters.

housing stumbles

The hot housing market of the past year has been slowing rapidly, as a sharp rise in mortgage rates has exacerbated affordability problems.

In April, new home sales fell the most in nearly nine years, according to government data on Tuesday. The measure of contract signings on previously owned homes fell for the sixth month in a row, the longest decline since 2018.

The data shows that the Fed’s rate hike and announcement of further increases significantly dampens demand. Mortgage rates, which have fallen in the past two weeks, are still hovering around their highest levels since 2009, according to Freddie Mac.

In another sign of the slowing pace of the market, the number of home sellers cutting asking prices reached the highest level since October 2019. Redfin Corp data also showed that listing prices stagnated.

Manufacturing moderation

Government figures this week showed a 0.8% rise in core capital goods shipments that could allow for more steady equipment trading expenses at the start of the second quarter. Meanwhile, growth in core orders slowed after rising in March.

The figures indicate that companies are committed to capital spending plans as they seek to improve productivity to ease the burden of high inflation and a tight labor market. However, it is not clear whether companies will reconsider the current pace of investment later this year in the face of higher interest rates and expected stagnation in economic growth.

The latest regional Fed surveys showed a clear reversal in activity. Manufacturing metrics in New York State, the Richmond and Philadelphia Federal Reserve regions fell in May and are at or near their lowest levels since mid-2020.

Weaker production growth, along with a recovery in inventories, may help reduce demand for foreign-made goods and materials. The government reported Friday that the merchandise trade deficit shrank by nearly $20 billion in April.

Imports fell 5% in the month due to lower demand for industrial inputs, capital goods and consumer goods.